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Shariah banking: Indonesia's 'bold plans' for a troubled industry

Mixed prospects for Islamic-friendly finance in world's most populous Muslim country

An employee at BRI Syariah bank in Jakarta: The government is trying to boost growth in the Islamic fiance sector. (AFP/Jiji)

JAKARTA -- In the world’s most populous Muslim nation, and under an administration keen to develop its Islamic economy, Indonesia’s oldest Sharia-compliant bank should have stood strong.

Instead, Bank Muamalat almost collapsed earlier this year under the weight of plunging profits and bad financing -- even as the government was making a push to quadruple the size of Sharia banking in Indonesia in just five years.

Fortunately, the country’s new vice president, Ma’ruf Amin, who is also a Muslim cleric, stepped in to help. Amin, who has a conservative reputation, is the head of Muamalat's Shariah board, and according to Tempo, a local magazine, he was soon discussing a rescue plan with President Joko Widodo.

Muamalat is not the only Islamic lender facing challenges in the country, despite its population of 220 million Muslims. Nor is it the only sector struggling to accommodate the raft of Islam-complaint initiatives that Widodo has encouraged to shore up domestic political support as he begins his second five year term.

A mandatory halal labeling rule for consumer products and services has drawn howls of protest from local producers who say they will struggle with the new regulation. An even bigger uproar followed a proposed ban on sex outside of marriage.

Widodo’s desire to increase Sharia-compliant banking, where loans are structured as profit-sharing agreements in order to comply with religious prohibitions on usury, has attracted far less headlines. But the initiative, despite its potentially huge pool of customers, is arguably no less fraught.

The sector, which accounts for just 5% of Indonesia's overall banking market, has long been plagued by a lack of attractive assets, poor marketing and inadequate human resources.

"Hopefully we in Shariah banking are not just good at reciting [the Quran] but also good at banking," one banker commented at a recent Jakarta conference that discussed the issues faced by Shariah banking.

Certainly, prospects seem promising. Aceh, the only Indonesian province formally adopting Shariah-compliant ordinances, with a population of 5 million, has required all local banks to also comply with Shariah. Shariah banks, including the subsidiaries of major conventional players, which control assets worth 492 trillion rupiah ($34.8 billion) between them, are keen to capitalize on the move.

Take BRIsyariah, the Shariah unit of state-owned Bank Rakyat Indonesia, Indonesia's largest lender by assets.

In Aceh, all of Bank Rakyat Indonesia's operations will have to be transferred to BRIsyariah, which went public last year, to comply with the new requirement, which goes into full effect in 2021. This will add 2 million customers to the Shariah lender's existing base of 2.8 million, and add 13.5 trillion rupiah ($962 million) in assets to its 36.8 trillion rupiah as of June.

"We've been preparing the permits and infrastructure to convert the business portfolio of the parent company, BRI, in Aceh," BRIsyariah corporate secretary Mulyatno Rachmanto, told the Nikkei Asian Review. "The implementation of the … bylaw will have a big impact on improving the performance of BRIsyariah, be it in the aspects of funding, financing or profitability."

Indonesia ranks 10th in the Islamic finance rankings compiled by Thomson Reuters and DinarStandard in the 2018/19 State of Islamic Economy Report. Malaysia, Bahrain and the United Arab Emirates occupy the top three places.

The new requirement in Aceh alone will add an estimated 28.2 trillion rupiah to the Shariah banking industry's total assets.

Elsewhere, provincial governments are planning to convert local banks they own to Shariah-compliant entities, following the successful conversion of Bank NTB into Bank NTB Syariah in West Nusa Tenggara Province last year. Among those looking to follow suit are Bank Nagari in West Sumatra Province and Bank Riau Kepri in Riau Province.

At the national level, the financial authority, OJK, plans to issue a regulation this year that will allow Shariah units to use the existing infrastructure of their parent companies. This is partly to facilitate the requirement that conventional banks turn their Shariah window operations into stand-alone subsidiaries by 2023.

Moody's Investor Service has praised Indonesia's progress in boosting Shariah finance, which Jakarta wants to increase from a market share of 5.96% at the end of last year to 20% by 2024.

"We believe the governments of Malaysia and Indonesia will continue to be committed to developing Islamic banking, and they are on track to meet their ambitious growth targets for the sector," Moody's said.

Others are less upbeat. In a PwC Indonesia survey last year, most bankers predicted that Shariah banking will grow little if at all in terms of market share over the next eight years.

Industry players at the Islamic banking seminar in Jakarta last month were similarly skeptical. Many pointed to Shariah banks' limited and less attractive products compared with their conventional counterparts, their overlapping target markets, and human resource problems.

"Shariah banks should not stop at [which are] halal and [which are] forbidden. They have to make breakthrough [products to outperform] conventional banks," one banker said.

BTPN Syariah, the Shariah subsidiary of Bank BTPN, is one of the few trying to set itself apart by targeting women from low-income rural households, who are seen as more likely to repay loans than men in the same situation.

"The main segment served by BTPN Syariah is the productive poor, or the unbanked, so there is a spirit of financial inclusion there," Bank BTPN President Ongki Wanadjati Dana said. "That is part of BTPN's primary strategy to enter the mass market."

Gary Hanniffy, director of financial institutional group at Fitch Ratings Indonesia, says Indonesia's Shariah banks have developed a wider variety of products but need to market them and educate their customers better. Shariah banks, with smaller budgets, tend to advertise much less aggressively than their bigger conventional counterparts.

He also agreed on the need for human resources in Shariah banking, particularly in risk management. "The Shariah sector as a whole versus the conventional banking sector, we've seen it's been weaker in terms of asset quality. There is more that needs to be done across the sector in terms of trying to improve risk management," Hanniffy told Nikkei.

The controversy surrounding Bank Muamalat is a case in point. The bank's poor risk management has been blamed for its persistent problems with nonperforming financing -- the equivalent of nonperforming loans at conventional banks -- which reached 4.5% net in the first half of this year. The bank's net profit plunged to 5.1 billion rupiah from 103.7 billion rupiah in the same period of last year.

Hanniffy also added the 2023 spinoff requirement has not been well received by some banks, again citing asset quality concerns. "Some of them would prefer if they could actually maintain the unit within the bank," he said. "Because as a separate entity it needs to have senior management, separate commissioners overseeing. And in their view it kind of weakens some of the oversight that they have over the subsidiary."

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